Securities Mosaic® Blogwatch
March 15, 2013
Gibbons v. Malone: Differences Between Securities in Same Company Essential when Avoiding the Application of Section 16(b) of the Securities Exchange Act
by Lincoln Puffer

In Gibbons v. Malone, No. 11-3620-cv, 2013 WL 57844 (2d Cir. Jan. 7, 2013), the Second Circuit concluded that section 16(b) of the Securities Exchange Act of 1934 does not apply when an insider sells one class of stock and purchases another class from the same company. The court held that section 16(b) is inapplicable when the shares sold and bought are "separately traded, nonconvertible stocks with different voting rights."

In December of 2008, the director of Discovery Communications, Inc. ("Discovery"), John Malone ("Malone"), sold 953,506 shares of his "Series C" stock. That same month, Malone bought 632,700 shares of Discovery's "Series A" stock. Plaintiff Michael Gibbons filed a shareholder's suit alleging that Malone violated the short swing profits provision contained in Section 16(b) of the Exchange Act. 15 U.S.C. 78p(b).

The trial court dismissed Gibbons' complaint. The trial court found that Section 16(b) did not apply to purchases and sales of different types of stock of the same company where the securities were "separately traded, nonconvertible, and [came] with different voting rights."

On appeal, the Second Circuit noted that section 16(b) endeavored to prevent corporate officers from unfairly profiting from the utilization of insider information by selling and buying, or buying and selling, a corporation's security within a six-month period. The language of Section 16(b), however, applied to the purchase and sale, or sale and purchase, of "any equity security." The court viewed the language as applying the prohibition on short swing profits only to transactions in the same equity security. See Id. ("Congress's use of the singular term 'any equity security' supports an inference that transactions involving different equity securities cannot be paired under § 16(b).").

Accordingly, the court grappled with determining whether Discovery's Series A stock and Series C stock were the "same security," or at least so similar as to render them subject to Section 16(b). In making this determination, the court noted several distinctions between the Series A and Series C stock. First, they were not "economically equivalent" because the price of each fluctuated relative to the other. Second, Series A stock conferred voting rights to its holder while Series C did not. Finally, the two stocks were not convertible. The court noted that convertibility between the two stocks could be sufficient evidence that the stocks were similar enough to apply section 16(b). As a result of these distinctions, the two series were not the same security within the meaning of section 16(b).

A Race to the Bottom post on the district court's ruling of this case may be found here. The primary materials for this case may be found on the DU Corporate Governance website.

March 15, 2013
Institutional Investors Should Not Facilitate Corporate "Ambushes"
by Trevor S. Norwitz

The following post comes to us from Trevor Norwitz, a partner at Wachtell, Lipton, Rosen & Katz in New York and a lecturer-in-law at Columbia Law School:

In the upcoming proxy season, shareholders at several major corporations will be asked to vote on proposals submitted by shareholder activists requesting that the board of directors facilitate the ability of shareholders to act by written consent. This means that, rather than the most important decisions being made at an annual or specially called shareholders meeting, such fundamental changes as replacing the board or even selling the company could be made, in many cases, with the pen stroke of a bare majority of shareholders, often without notice or information to other shareholders, and without time for thoughtful consideration. Companies can be caught completely by surprise- "ambushed"- when fundamental changes are presented to them as a fait accompli.

Because unexpected upheavals are so disruptive, and the threat of them so distracting to boards and management, most state corporation laws only permit action by written consent if it is unanimous, unless a company's charter provides otherwise. The charters of most widely held public companies (even in Delaware where the statutory presumption is reversed) do not permit action by written consent but require that shareholders act at meetings, so that all shareholders will receive proper notice and information about the issues to be considered, hear both sides of any contested matter, and have adequate time for reflection.

Reasonable minds can and do differ as to whether some subset of the shareholders should be able to convene special shareholder meetings in between annual meetings. American corporate law- like our political system- has generally embraced a "republican" form of democracy, in which shareholders elect a board of directors whom they entrust to oversee management and, if they are dissatisfied, can replace at the next election. In recent years, however, trade unions and shareholder activists, supported by powerful proxy advisory firm ISS, have had considerable success making California-style recall elections the norm. This is part of a sea-change that is shifting corporate America from its traditional board-centric approach to a European-style model in which major decisions about corporate direction and policy are made by shareholders (or really by unelected shareholder intermediaries), rather than by boards of directors, who are elected and subject to strict fiduciary duties. A variety of developments has brought this about, most significantly the widespread adoption of majority voting in director elections, coupled with the ever-tightening ISS policy of recommending that shareholders reject directors who do not accede to their demands. Having virtually eliminated takeover defenses like standing "poison pills" and staggered boards, the activists are now seeking to ensure that shareholders can take action (most importantly, to remove the board and sell the company) at any moment. This shift towards shareholder intermediary-centric governance has lead to an over-emphasis on short term results, to the significant detriment of the economy and the employees of companies forced to reduce investment and employment to avoid short term declines in performance.

While reasonable investors might favor having the right to ask for recall elections, it is difficult to formulate a reasonable basis for allowing shareholders in widely-held public companies to act by written consent rather than by meeting. Action by consent is essentially a convenience mechanism that dispenses with the requirement for a meeting because the outcome is a foregone conclusion. This makes sense for companies with controlling shareholders. But for almost all public companies, the difference between having to act at a meeting and being able to act without one is effectively the ability of a handful of large shareholders to sell the company without having to take into account the views or votes of, or even to inform, the rest of the shareholders. It is an in terrorem pressure tactic to be exploited by hostile bidders, and an Achilles heel which can deny directors a reasonable ability to maximize shareholder value.

Most shareholder activists and many institutional investors today want America's corporations to be vulnerable to hostile takeovers. Whether they are right that this will lead to a more efficient allocation of capital, or whether this is an imprudent and short-termist position, is debatable. But in any case, hostile takeovers do not depend on shareholders being able to act by written consent. The right to remove directors at the next annual meeting should arguably be sufficient, but certainly a raider needs no more than to be able to act at a special meeting. All the written consent adds is an element of uncertainty and coercion- the risk that a raider can knock on the door waving a few pieces of paper and say: "Hand over the keys, this is my company now!"- that can deny the board the opportunity to make a value-maximizing decision.

Prudent and responsible institutional shareholders should not support the activists and ISS in their efforts to mandate shareholder action by written consent, which will be distracting and destabilizing for America's public corporations.

March 15, 2013
Rakoff, Naftalis, and Brodsky Discuss the Gupta Insider Trading Case at Columbia Law School
by Jason W. Parsont

On February 21, United States District Court Judge Jed S. Rakoff, federal prosecutor Reed Brodsky, and defense attorney Gary Naftalis, came together to discuss the Gupta insider trading case with Columbia Law School students in a seminar called Corporations in the Court: An Insider Look at Major Corporate Cases, co-taught by Professor John C. Coffee, Jr. and Delaware Supreme Court Justice Jack B. Jacobs.

Judge Rakoff presided over the Gupta case in the United States District Court for the Southern District of New York, Mr. Brodsky prosecuted the case, and Mr. Naftalis defended the main protagonist, former Goldman Sachs director Rajat Gupta.

Mr. Gupta was convicted of insider trading violations last year on account of boardroom secrets he allegedly provided to hedge-fund manager Raj Rajaratnam. This included a tip to Rajaratnam that Warren Buffett's business would be injecting $5 billion into Goldman Sachs during the height of the financial crisis. Gupta was sentenced by Judge Rakoff to two years. He is currently appealing the conviction in the United States Court of Appeals for the Second Circuit.

Judge Rakoff and Messrs. Naftalis and Brodsky offered a behind-the-scenes look at the case. They discussed the various stages from pre-indictment, to the SEC's controversial administrative proceeding, to sentencing, and they also touched upon the contentious topic- now on appeal- of the admission of critical wiretap evidence. Part of the discussion was off the record and this post does not include those portions.

Mr. Brodsky began by discussing some of the reasons that the indictment of Gupta had long been stalled. "The government," he explained, "simply can't do everything at once." During the pre-indictment period, Mr. Naftalis wasn't expecting his client to face criminal charges. "Gupta lived an exemplary life," he said. "He had no economic motivation for tipping, wasn't wanting for money, and received no financial benefit. He was different than anyone else charged on the matter, hedge fund traders and the like."

The SEC's controversial administrative proceeding against Gupta came as a surprise to Naftalis. "Administrative proceedings in insider trading cases were rare and all the others went to Federal Court," he said. To fight this forum choice, Naftalis had to craft a novel complaint that admittedly had "no precedents." Yet, his process was pure common sense: "We got a bunch of smart people around a table to discuss potential grounds." His equal protection argument eventually convinced Judge Rakoff to deny the SEC's motion to dismiss, which led the case back into federal court.

There, one of Naftalis' most contentious motions was one to suppress wiretap evidence from being introduced at Gupta's criminal trial. The defense was fighting an uphill battle, however, in light of Judge Holwell's recent wiretap decision in the Rajaratnam case. Not surprisingly, Judge Rakoff balked at finding Holwell's conclusions to be in error.

Judge Rakoff's decision arguably influenced the outcome at trial. Although the prosecution brought substantive charges based on four tips, the jury convicted only on the two supported by wiretaps. Brodsky nonetheless exclaimed that "there was sufficient circumstantial evidence to convict Gupta even without the wiretap evidence." He said, "approximately 16 seconds after the Goldman board meeting where Gupta learned of the Buffett investment, Gupta's assistant called Rajaratnum and put Gupta on the call. Within minutes of that call, two minutes before the close of the market, and prior to the public release of the information, Rajaratnam ordered his trader to buy Goldman Sachs."

Naftalis and appellate counsel Seth Waxman filed their appellate brief on January 18, 2013. It alleges that the Court erred in admitting the wiretaps and excluding critical defense evidence. Based on the current briefing schedule the case will become ripe on April 12, 2013. It will be an interesting case to follow.

March 15, 2013
Survey Results: Shareholder Engagement
by Broc Romanek

Survey Results: Shareholder Engagement

Here are the results from our recent survey on shareholder engagement:

1. Before our annual meeting, our company actively seeks engagement with this number of institutional shareholders:
- More than 50- 0%
- 26-50- 12%
- 21-25- 12%
- 10-20- 12%
- 6-10- 24%
- 1-5- 6%
- None- 36%

2. Before our annual meeting, our company has actual engagement with this number of institutional shareholders:
- More than 50- 0%
- 26-50- 6%
- 21-25- 0%
- 10-20- 12%
- 6-10- 24%
- 1-5- 29%
- None- 29%

3. Before our annual meeting, our company typically receives unsolicited requests from this number of institutional investors:
- More than 5- 0%
- 3-5- 6%
- 1-2- 24%
- None- 71%

4. If we receive unsolicited requests from institutional investors for engagement, our company:
- Always will engage with those investors- 60%
- Will engage some of the time with those investors- 33%
- Never will engage with those investors- 7%

Take a moment for our "Quick Survey on Separating 401(k) SPD & Prospectus" and "Quick Survey on End-User Exception for Swaps."

Effective Board Diversity Change: Start with Baby Steps

In this podcast, Sylvia Groves of Governance Studio describes her efforts to diversify boards, including:

- Why do you think a diversity problem still exists in the boardroom?
- What is your "Diversity One Policy" idea?
- How is that better than "pink quotas"?
- How would your idea work in practice?

Mailed: January-February Issue of "The Corporate Executive"

We have mailed the January-February Issue of The Corporate Executive, and it includes pieces on:

- A Heads Up: IRS Comments on Excess Withholding
- Automatic Exercise at Expiration: Has the Time Come?
- Option Expiring When the Market Is Closed

Act Now: Get this issue rushed to when you try a 2013 No-Risk Trial to The Corporate Executive.

- Broc Romanek

March 15, 2013
This Week In Securities Litigation (Week ending March 15, 2013)
by Tom Gorman

Mary Jo White, selected by the President as the next Chairman of the SEC, testified in her confirmation hearings before a Senate Committee this week. Ms. White promised the Committee that under her the agency would complete rule making for Dodd-Frank and the JOBS Act. The enforcement program would be "bold and unrelenting" the Committee was told.

SEC Enforcement brought another proceeding this week against a state tied to inadequate disclosures about its unfunded pension obligations when selling bonds. Actions were also based on related to investment funds overvaluing assets and using an agent to solicit investors who was not a registered broker dealer. An executive who traded in advance of a tender offer made by his company settled with the SEC as did two twin teen brothers in the UK who solicited investors with what they claimed was a stock picking robot. Finally, the agency announced the remedies obtained against one defendant in a 2006 old market timing case where the jury found in part in its favor on a negligent fraud theory but for the defendant on all scienter based claims.


Remarks: Norm Champ, Director, Division of Investment Management, addressed the Investment Advisers Compliance Best Practices Summit 2013 (Washington, D.C. March 11, 2013). His remarks included comments on rule making initiatives under the JOBS Act, a new position in the division that will focus on communicating with the asset management industry, and the Division's recent initiative under Dodd-Frank to create the Risk and Examinations or REG group (here).

Confirmation hearings

Testimony: Mary Jo White, President Obama's nominee to become Chairman of the SEC, testified before the Senate Committee on Banking, Housing and Urban Affairs as part of the confirmation process. Her brief testimony focused largely on three key points: 1) Rule making:It is essential that the Commission finish "in as timely and smart a way as possible" rule making under Dodd-Frank and the JOBS Act. It needs to be "right, but it also needs to get done." 2) Enforcement:Enforcement will be a "high priority [and it] must be bold and unrelenting 3) Markets: While experts disagree about the impact of high speed trading, dark pools, complex trading algorithms and intricate new order types, what is critical is that "a sense of urgency [be] brought to addressing these issues "

SEC Enforcement: Litigated cases

Market timing: SEC v. O'Meally, Civil Action No. 06-CV-6483 (S.D.N.Y.) is a market timing action filed in 2006 against four registered representatives formerly employed by Prudential Securities, Inc. Three defendants settled. Defendant Fredeick O'Meally went to trial. The jury returned a verdict according to the verdict form: 1) Against the Commission on a count based on Exchange Act Section 10(b); 2) Against the Commission on a count based on Securities Act Section 17(a); 3) Against the Commission on a count based on intentional or reckless conduct under Securities Act Section 17(a)(2) and (3); 4) In favor of the Commission on a count based on negligent conduct under Securities Act Section 17(a)(2) and (3). In reaching its verdict the jury only found in favor of the Commission on six of the thirty three funds listed on the verdict form. This week the court entered an order directing Mr. O'Meally to pay $444,836 in disgorgement, prejudgment interest and a civil penalty of $60,000. The complaint alleged that when certain mutual funds attempted to block the trading of the defendants and their clients because they were market timing, fraudulent and deceptive practices were used to continue. See also Lit. Rel. No. 22643 (March 13, 2013).

SEC Enforcement: Filings and settlements

Weekly statistics: This week the Commission filed 3 civil injunctive actions and 4 administrative proceedings (excluding tag-along-actions and 12(j) actions).

Investment fund fraud: SEC v. Wilson, Civil Action No. 2:13-cv-00188 (D. Utah Filed March 14, 2013) is an action against Edmund Wilson and Walter Ross related to the sale of securities by Fountain Group of Companies of Utah, Inc. Defendant Wilson was the president of the now defunct company. The defendants sought investors with real estate projects for their "substitution of collateral program." Under this method of financing for a fee of either $80,000 or $150,000, paid to activate funding, millions of dollars could be raised from a form of collateral that was self-liquidating, meaning it did not have to be repaid. About $11 million was raised. Rather than invest the funds however, Mr. Wilson funneled them through other controlled entities. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Lit. rel. No. 22644 (March 14, 2013).

Investment fund fraud: SEC v. Hunter, Civil Action No. 12-cv-3123 (S.D.N.Y.) is an action against two teenage twin brothers who reside in the U.K., Alexander and Thomas Hunter. The brothers solicited thousands of investors through two websites which offered subscription based e-mail newsletters with stock picks from Merl, the stock picking robot who was alleged to have an excellent record of good returns. Over 47,000 investors, mostly from the U.S., signed up. The brothers made about $1.2 million in subscription fees. They also sold a home version of the software for the robot. What subscribers were not told is that the results were not from Marl but a another business of the brothers. Through another website they marketed their subscriber list to penny stock promoters as a way to boost their stock price. From this they were paid about $1.8 million to promote specific stocks. When U.K. authorities discovered the brothers they attempted to move their operations to Panama. This week both brothers settled with the SEC, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, Alexander will pay a $100,000 penalty while his brother will pay $75,000. No disgorgement was ordered. See also Lit. Rel. No. 22641 (March 12, 2013).

Insider trading: SEC v. Lackey, Civil Action No. 2:13-CV-2153 (W.D. Tenn. Filed March 11, 2013) is a settled insider trading case against Michael Lackey, formerly Vice-President and General Manager of International Paper Company. The case centers on the tender offer by his employer for Temple-Inland, Inc., announced on June 6, 2011. On April 30, 2011 Mr. Lackey attended a charity event with Executive A who was part of a team working on the tender offer. During the event the two men discussed the possible acquisition of Temple-Island. Mr. Lackey learned, according to the complaint, that there was "a good chance" the deal would proceed. Between May 2 and June 1, 2011 Mr. Lackey purchased 9,000 shares of Temple-Island in two accounts. At the time of the purchases International Paper had policies and procedures which required its employees to maintain the confidentiality of its information. Following the deal announcement Mr. Lackey sold his holdings, yielding profits of $56,533.89. The Commission's complaint alleges violations of Exchange Act Sections 10(b) and 14(e). Mr. Lackey settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. He also agreed to pay disgorgement in the amount of his trading profits, a penalty in that amount and prejudgment interest. See also Lit. Rel. No. 22640 (March 11, 2013).

Misleading disclosure: In the Matter of State of Illinois, File No. 3-14237 (March 11, 2013) is a proceeding which names as a Respondent the State of Illinois. It claims that the State mislead investors when selling about $2.2 billion in bonds over a four year period beginning in 2005. The proceeding alleges violations of Securities Act Sections 17(a)(2) and (3). Facing rising costs and a growing unfunded pension liability, in 1994 the State Assembly passed legislation designed to rectify the situation. Essentially the statutory plan called for achieving a 90% funded ration for each system by 2045. Part of the plan called for the State's contributions to ramp up over a fifteen year period. This permitted Illinois to shift the burden associated with its pension costs to the future, creating a structural underfunding. From 1996 through 2010 the unfunded liability increased by $57 billion. Significant financial stress resulted. In its bond offering documents the State disclosed the Illinois statutory funding provisions but not that the plans were continually being underfunded. The deficit became worse in 2005 when the State amended the statutory plan and lowered the contributions or borrowed to cover the payments. Again the basic facts were disclosed but investors were not told that these actions exacerbated the structural underfunding, according to the Order. This resulted from the fact that the State failed to adopt or implement sufficient controls, policies, or procedures to ensure that material information was collected and disclosed. By 2009 the State began to take remedial steps. The proceeding was resolved in view of those actions, the continuing remedial efforts of the State and its cooperation. The State consented to a cease and desist order based on the Sections cited in the Order.

False valuation: In the Matter of Oppenheimer Asset Management Inc., Adm. Proc. File No. 3-15238 (March 11, 2013) is a proceeding which names as Respondents the management firm and Oppenheimer Alternative Investment Management, LLC, both of whom are registered investment advisers. The two advisers managed a fund of funds. From October 2009 through the following year the fund's reports represented that its assets were valued based on the underlying managers' estimated values. At the time the largest holding of the fund was Cartesian Investors-A LLC. Contrary to the representations in the materials it was valued at a price increased by the portfolio manager. This had the effect of materially increasing the valuation of the fund. Investors were told that the increased valuation of the fund was due to performance, rather than the valuation. This occurred in part from a failure to have proper procedures. The Order alleged violations of Securities Act Sections 17(a)(2) and (3) and Advisers Act section 206(4). Respondents resolved the proceeding, consenting to the entry of a censure and a cease and desist order based on the Sections cited in the Order. In addition, they agreed to pay $2,269,098 in disgorgement and prejudgment interest. A portion of that amount was satisfied by a payment to settle a similar case brought by the Commonwealth of Massachusetts. Respondents are also required to pay a civil penalty of $617,579, an amount based on their cooperation and retain an independent consultant.

Unregistered broker: In the Matter of William M. Stephens, Adm. Proc. File No. 3-15233 (March 8, 2013) is a proceeding against Mr. Stephens for acting as an unregistered broker in violation of Exchange Act Section 15(a). In 2002 Mr. Stephens settled a Commission proceeding based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2) centered on the investment of pension fund assets. There Mr. Stephens was the subject of a cease and desist order and barred from association with any investment adviser with the right to reapply after two years. He also was directed to pay a $25,000 civil penalty. He never reapplied. In this case he worked as an independent consultant for Ranieri Partners LLC which controls two entities that managed the investments of two funds. Those funds are advised by another entity controlled by Ranieri which is now a registered investment adviser. Beginning in 2008, and continuing for the next three years, Mr. Stephens was retained to raise money for the two funds. In that role he forwarded materials to investors including private placement memoranda and subscription documents; urged at least one investor to consider adjusting its portfolio allocations to accommodate an investment in the funds; and provided investors with confidential information about other investors and their capital commitments. In return he was paid transaction based compensation which over the period totaled about $2.4 million. Mr. Stevens settled with the Commission, consenting to the entry of a cease and desist order based on Exchange Act Section 15(a). He also agreed to be barred from the securities business and from association with an investment adviser and participating in a penny stock offering. While the Order directs that he pay disgorgement of about $2.4 million along with prejudgment interest, payment was waived based on his financial condition.

Unregistered broker: In the Matter of Ranieri Partners LLC, Adm. Proc. File No. 3-15234 (March 8, 2013) is the companion proceeding to In the Matter of William M. Stephens, discussed above. Respondent Ranieri Partners is the holding company of the funds and Respondent Donald Philips was the senior managing partner and a friend of Mr. Stephens. The Order alleges violations of Exchange Act Section 15(a) based on essentially the same facts as detailed above. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on Exchange Act Section 15(a). In addition, Ranieri agreed to pay a civil money penalty of $375,000. Mr. Phillips was suspended from association in a supervisory capacity from the securities business for a period of nine months and agreed to pay a penalty of $75,000.

Offering fraud: SEC v. Brown, Case No. CV 13-01629 (C.D. Cal. Filed Mar. 7, 2013) is an action against First Choice Investment, Inc., Advanced Corporate Enterprises, Inc., and their principal, Alvin Brown. It centers on essentially two on-going offering frauds. One started in January 2011 and continued at the time the complaint was filed. Through this offering Mr. Brown and FCI raised about $1.2 million by falsely promising returns on a real estate investment of 10% and a future IPO that would yield 150%. The returns have not materialized but Ponzi-like payments have been made. ACorp also engaged in a real estate offering fraud beginning in 2005 which raised almost $2 million over five years. Investors were falsely promised high returns and investment safety. Mr. Brown is alleged to have misappropriated the offering proceeds. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b). A TRO and freeze order requested by the Commission was granted. The case is in litigation. See also Lit. Rel. No. 22642.


Remarks: Richard Ketchum, Chairman and CEO of FINRA, addressed the Consumer Federation of America Consumer Assembly, Washington, D.C. (March 14, 2012). His remarks focused on the effect of a uniform fiduciary standard for those who render investment advice (here).


Investment fund fraud: John Sanders, Michael Strubel and Spencer Steinberg were charged with conspiracy to defraud in connection with an alleged Ponzi scheme. The three men claimed to be selling high value contracts related to Saunders Electrical Wholesalers Ltd, London. They have raised about 44 million over a four year period beginning in 2010. The UK Serious Frauds Office has arrested the men. Mr. Steinberg was also charged with serving as a director while disqualified.


Insider dealing: Richard Joseph was found guilty of six counts of conspiracy to deal as an insider. He was sentenced to serve four years in prison on each count. The sentences will run concurrently. Mr. Joseph obtained inside information on potential take-overs from a financial printer employed at JP Morgan Cazenove. Although the information was coded he was able to place spread bets in advance of the transactions and profit. Two years ago five others were convicted as part of the scheme which the Financial Services Authority has kept confidential until now.


Conflicts: The Securities & Futures Commission of Hong Kong banned Calvin Ho Kei Him from the securities business for a period of fourteen months. He was an associate at Morgan Stanley Asia Limited from November 2009 through November 2011. He was banned for failing to identify and disclose to his employer all securities accounts related to him and their stock trading activity; not taking adequate steps to avoid conflicts between the activity in the accounts and his employment as a research associate; and making false or misleading declarations regarding outside accounts.

March 14, 2013
What to Expect This Proxy Season: Findings from Proxy Preview
by Celia Taylor

As proxy season gears up, the new Proxy Preview report issued by As You Sow, an organization dedicated to "helping shareholders vote their values" contains a wealth of interesting information. Shareholders advocacy is gaining force. According to the Preview, investors this year will file approximately 400 shareholder proposals on social and environmental issues-a 50% increase over a decade ago While not all of these will result in votes, many of those that do not will encourage management-shareholder dialogue leading to the withdrawal of a proposal after the proponent reaches some agreement with management.

Not surprisingly, many of the resolutions filed center on corporate political spending. About 120 resolutions focus on political spending, about one-third of the total number of resolutions, and twice the number filed on the next most popular category this year: climate and energy.

"The trend on political spending has been around for several years now, and much of that has focused on political contributions to elections. But what started last year and kind of exploded this year is political lobbying disclosure," says Michael Passoff, co-author of the Proxy Preview and CEO of Proxy Impact, a progressive proxy voting service for socially responsible investors.

"In essence, what shareholders are asking for is disclosure on the political spending done on elections but also year-round," he says.

Resolutions concerning climate and energy, other environmental issues, and sustainable governance (including reporting) combined make up about equal parts of another 38% of the total. Human rights and decent work proposals make up a modest 8%, although some of these concerns are folded into the sustainability reporting requests. Proponents continue to promote board diversity and the need for board oversight of several different issues, accounting for another 6%, while employment diversity-mostly related to equal rights for lesbian, gay, bisexual, and transgender people-make up a further 6% with the remainder being a grab-bag.

Even though environmental topics are not the largest category of shareholder proposals, they remain important avenues for shareholder advocacy. Investors filing proposals concerning environmental issues want companies to adopt policies for lowering emissions that are driving climate change and to report on how they are managing and mitigating related risks. In additional to proposals addressing climate change, environmental topics of concern to shareholders include, among others, the impact power sector companies (coal, shale gas, and nuclear) operations have on the environment, recycling and product responsibility, toxic materials, and water and forest management.

As discussed in an earlier posting, proposals addressing environmental concerns got a boost from the SEC this season when it refused to grant a no-action letter to PNC Financial Services which sought to block a proposal seeking the firm's "assessment of the greenhouse gas emissions resulting from its lending portfolio and its exposure to climate change risk in its lending, investing, and financing activities." In an apparent SEC policy change, the Commission refused to concur with PNC Financial that it could exclude the proposal on the grounds that it dealt with ordinary business matters and instead found that it must be included as a proposal addressing an important social policy concern. This ruling potentially opens a door for more resolutions seeking climate change risk assessments throughout the financial sector.

Just who is bringing these proposals? There are a wide range of groups responsible, ranging from big players including socially responsible investment firms Trillium Asset Management, Calvert Investments and Walden Asset Management, who together filed the most resolutions for 2013, followed by pension funds and faith-based groups. Individual proponents accounted for just 6 percent of the total filings this year. Support for proposals also continues to increase. The average support level has grown from 11.9% in 2003 to 18.5% in 2012. "Now you get a lot of votes that are in the 30 percent range, and some are majority votes," Passoff says. There is a trend of companies being more responsive to socially responsible investing, and mainstream investors are supporting them as well," he says.

The Preview includes far more information than can be summarized here, including an analysis of past proxy season results and outcomes. What is clear from this year's preview is that shareholder activism on social and environmental issues continues to grow and it will be harder and harder for companies to ignore.

March 14, 2013
Chancery and Proxy Puts
by Francis Pileggi

Kallick v. Sandridge Energy, Inc., C.A. No. 8182-CS (Del. Ch. Mar. 8, 2013).

The highly regarded corporate law scholar Professor Larry Hamermesh has provided his insights on this decision in highlights available on his blog at The Institute of Delaware Corporate & Business Law. The entire post follows:

Chancellor Strine's March 8, 2013 opinion in Kallick v. SandRidge Energy is a welcome reaffirmation and clarification of director duties in relation to takeover deterrents built into otherwise customary commercial transactions in this case, a put right (the "Proxy Put") in the company's credit agreements that would require the company to refinance debt in the event of a change in the majority of the board not approved by a majority of the pre-existing directors.

Responding to a dissident hedge fund's consent solicitation to replace the board, the company (SandRidge) made the (in hindsight) grievous error of warning its stockholders that replacing the board could result in "mandatory refinancing of [a] magnitude [that] would present an extreme, risky and unnecessary financial burden" on the company. Talk about playing right into the dissident's hands! You don't have to be as smart as Chancellor Strine to figure out that this great a burden on the electoral franchise requires some explanation. Who agreed to it? Why? And why can't the burden be avoided? The company later tried to ride a different horse, claiming that the Proxy Put was no problem after all, because refinancing would be easy and inexpensive- a better argument in light of Unocal, of course, but regrettably awkward in light of the company's prior position .

Those first two questions how and why did the Proxy Put get there in the first place? didn't get much of an answer in the record. The Chancellor usefully reminded transactional lawyers, however, that playing with matches like the Proxy Put requires some care: "the independent directors of the board should police aspects of agreements like this, to ensure that the company itself is not offering up these terms lightly precisely because of their entrenching utility, or accepting their proposal when there is no real need to do so." SandRidge's lawyers involved in negotiating the credit agreements may have missed that message from the Court's 2009 opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharms., Inc., 983 A.2d 304, 315 (Del. Ch. 2009) ("The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting [a Proxy Put], it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it.").

In any event, what was done was done. The real question in the case was not how the Proxy Put got there, but what to do about it. The premise from which the Chancellor approached the question was that the board could "approve" the dissident candidates for purposes of the Proxy Put (and thereby avoid triggering it) without endorsing their candidacy. The question then became whether there was any reason not to grant such limited approval, and that's where the defendants' proof fell totally to the ground. The Court noted that there was nothing in the record to "indicate[] that any incumbent board member or incumbent board advisor has any reasonable basis to dispute the basic qualifications of the [dissident] slate." And the board's financial advisor conceded that approving the dissident slate for purposes of the proxy put wouldn't breach any obligation to the creditors.

And most notably, the Court found that:

[T]he incumbent board and its financial advisors have failed to provide any reliable market evidence that lenders place a tangible value on a Proxy Put trigger not a change in board composition accompanying a merger or acquisition or another type of event having consequences for the company's capital structure, but a mere change in the board majority.

It was this failure of proof that was defendants' undoing, given the application of a legal standard of enhanced scrutiny that requires the defendants to demonstrate at least some justification for insisting on maintaining whatever deterrent effect the Proxy Put imposed on the stockholder vote. Summarizing the governing legal rules, the Chancellor explained:

By definition, a contract that imposes a penalty on the corporation, and therefore on potential acquirers, or in this case, simply stockholders seeking to elect a new board, has clear defensive value. Such contracts are dangerous because, as will be seen here, doubt can arise whether the change of control provision was in fact sought by the third party creditors or willingly inserted by the incumbent management as a latent takeover and proxy contest defense. Unocal is the proper standard of review to examine a board's decision to agree to a contract with such provisions and to review a board's exercise of discretion as to the change of control provisions under such a contract.

The Court's approach to relief bought into a nuanced alternative thoughtfully put forward by plaintiff, who had originally asked for an order requiring the board to approve the dissidents' candidacies for purposes of the Proxy Put. Recognizing that such affirmative, mandatory relief is an uncomfortable, extraordinary thing for a court to award, the plaintiff alternatively (but no less effectively) sought an order preventing the company from soliciting revocations of stockholder consents so long as the board was declining to approve the dissidents' candidacies. And that's exactly what the Court granted.

The opinion also features a citation to the scholarship of a corporate law scholar often cited in Delaware opinions: Prof. Stephen Bainbridge, who discusses the citation on his own blog.

March 14, 2013
Substantial 2013 Results Already Produced by SRP and SRP-Represented Investors
by Lucian Bebchuk, Scott Hirst and June Rhee

Editor's Note: Lucian Bebchuk is the Director of the Shareholder Rights Project (SRP), Scott Hirst is the SRP's Associate Director, and June Rhee is the SRP's Counsel. The SRP, a clinical program operating at Harvard Law School, works on behalf of public pension funds and charitable organizations seeking to improve corporate governance at publicly traded companies, as well as on research and policy projects related to corporate governance. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University. The work of the SRP has been discussed in other posts on the Forum available here.

In its news alert released yesterday, the Shareholder Rights Project (SRP), working on behalf of eight SRP-represented investors, announced that proposals submitted for 2013 meetings have already had significant impact. As discussed below, major results obtained so far include the following:

  • Following active engagement, 46 S&P 500 and Fortune 500 companies that received shareholder proposals for 2013 annual meetings have already agreed to move towards annual elections.
  • These 46 companies represent more than 60% of the companies receiving shareholder proposals from SRP-represented investors for the 2013 proxy season.
  • Together with the 2012 work of the SRP, 91 companies - about three-quarters of the S&P 500 and Fortune 500 companies that received proposals in 2012, 2013 or both - have agreed to move towards annual elections. The aggregate market capitalization of these 91 companies exceeded one trillion dollars as of March 1, 2013.

As described in the SRP's November 2012 news alert, the SRP submitted shareholder declassification proposals on behalf of SRP-represented investors to 74 S&P 500 and Fortune 500 companies with classified boards for a vote at their 2013 annual meetings. Following active engagement with companies receiving proposals, 42 companies have entered into agreements to bring management proposals to declassify their boards for shareholder approval (a list of those companies that have already publicly disclosed the agreed-upon management proposals is available here). Furthermore, 4 other companies have declassified by amending their bylaws (where companies' classified board structures are set out in their bylaws, declassification may occur without a shareholder vote). The boards of these 46 companies should be commended for their responsiveness to shareholder concerns.

In addition to the 42 companies that will put forward management proposals to declassify pursuant to 2013 agreements with SRP-represented investors, 11 companies will put forward management proposals pursuant to agreements entered into following the submission of 2012 proposals by SRP-represented investors. Full details about the management proposals that will be brought to a vote pursuant to 2012 agreements with companies are available in the SRP's 2012 annual report.

The agreements resulting from 2013 proposals, combined with the large number of 2012 declassifications of S&P 500 companies that resulted from engagement with the SRP and SRP-represented investors (described in the 2012 annual report), are expected to bring about a major change in the governance landscape of large publicly traded firms. The SRP expects that, by the end of 2013, the work of the SRP and SRP-represented investors will have contributed to movements toward board declassification by a majority of the S&P 500 companies that had classified boards at the beginning of 2012.

The eight institutional investors on behalf of which the SRP is working are the Illinois State Board of Investment (ISBI), the Los Angeles County Employees Retirement Association (LACERA), the Nathan Cummings Foundation (NCF), the North Carolina Department of State Treasurer (NCDST), the Ohio Public Employees Retirement System (OPERS), the Massachusetts Pension Reserves Investment Management Board (PRIM), the Florida State Board of Administration (SBA) and the School Employees Retirement System of Ohio (SERS). The SRP provides SRP-represented investors with a wide range of services in connection with the submission of shareholder proposals, including submitting proposals on behalf of such investors, and assisting such investors in connection with designing proposals, selecting companies for proposal submission, engaging with companies, negotiating and executing agreements with companies to bring management declassification proposals, and presenting proposals at annual meetings.

March 14, 2013
Union de Empleados v. UBS Financial Services: Appellants Get a Second Chance
by Sarah Emery

In Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, Union de Empleados de Muelles de Puerto Rico AP Welfare Plan v. UBS Fin. Serv. Inc. of Puerto Rico, UBS Trust Co. of Puerto Rico,, Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan ("PRSSA") and Union de Empleados de Muelles de Puerto Rico AP Welfare Plan ("AP") (collectively, "Appellants") alleged that UBS Financial Services Inc. of Puerto Rico ("UBS Financial"), UBS Trust Company ("UBS Trust"), and the Directors of the entities (collectively, "Defendants") committed securities fraud by heavily investing in bonds. No. 11 1605, 2013 WL 49818 (1st Cir. Jan. 4, 2013). The district court dismissed the case; however, the appellate court vacated the dismissal and remanded the case for further proceedings.

The Appellants are Puerto Rico pension plans that invested in closed-end investment funds. According to the complaint, AP owned shares in four such funds, while PRSSA owned shares in three of four of the same funds. The board of each fund was identical. Similarly, each had the same investment advisor, UBS Trust. Acting in its role as investment advisor, UBS Trust purchased $757 million worth of bonds issued and underwritten by UBS Financial, an affiliate, and then sold those bonds to the funds. Appellants alleged that the funds were so heavily invested in these bonds that when the value of the bonds dropped, the funds suffered serious financial losses.

Appellants filed a derivative action. "A shareholder derivative action permits a shareholder of a corporation to bring suit to enforce rights the corporation is unable or unwilling to enforce on its own behalf." The trial court dismissed the action, finding that plaintiffs had not sufficiently pled demand futility. The trial court declined the request to file an amended complaint designed to cure the pleading deficiencies.

The court of appeals determined that the law of the state of incorporation governed the standard for demand futility. Since, the funds were incorporated in Puerto Rico, the court looked to the law of that jurisdiction. Because Puerto Rico had not set out standards for demand futility, the court opted to apply the law of Delaware. Id. ("we look to Delaware corporate law, on which Puerto Rico corporate law is modeled."). Under Rales v. Blasband, plaintiffs were required to allege facts that created "a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." 634 A.2d 927 (Del. 1993). Demand, therefore, would be excused only if the majority of the board is interested or lacks independence.

An identical eleven-person board governed each of the four funds. For the Appellants to prove demand futility, they had to create a reasonable doubt that six of the directors were not disinterested or independent. The court held that the Appellants alleged sufficient facts to meet this burden.

First, the complaint pointed to relationships between the directors and the Defendants that could preclude a finding that they were disinterested and impartial. Directors Ubinas, Highley, and Ferrer were not only on the board for each of the four funds, but they all served in various executive positions with either, or both, UBS Trust and UBS Financial. Director Roussin was a director of each of the four funds and a full-time employee of UBS Financial. The court found that these divided loyalties raised reasonable doubt about the ability of these directors to act in a disinterested fashion in evaluating Appellants' demand.

Lastly, the court looked at Directors Belaval and Leon, who shared nearly identical circumstances. Both directors were executives of Triple S. Triple S had a lucrative relationship with both UBS Trust and UBS Financial. Because of the prior dealings these directors had, on behalf of Triple S, with both institutional Defendants and the possibility that they will need the business assistance of the UBS Defendants in the future, a reasonable doubt was created about their independence.

Secondly, the trial court "misconstrued plaintiffs' burden of demonstrating that the benefits that the individual directors received" as part of their relationship with UBS Trust or UBS Financial were of "subjective material significance."

The court held that the Appellants' derivative claim should not have been dismissed. The dismissal was vacated and the case remanded for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website.

March 14, 2013
Answering Your Conflict Minerals Questions
by Broc Romanek

Answering Your Conflict Minerals Questions

We continue to post oodles of resources in our "Conflict Minerals" Practice Area, but I thought it was worth highlighting these FAQs from Scott Kimpel and Brian Hager of Hunton & Williams since they address issues that I keep hearing about:

Why do the final rules leave so many terms undefined and create so many interpretive issues?

We believe a number of factors contributed to the tone and structure of the final rules. As a threshold matter, the final rules involve a diverse array of issues such as human rights, international relations, global politics, supply chain management, chemistry, metallurgy and manufacturing technology. These topics are far afield from the agency's core experience and historical role as a securities regulator, and placed the Commissioners and agency Staff on a steep learning curve.

Second, though hundreds of commenters provided input and many multi-stakeholder groups were formed, commenters reached little consensus on many of the key issues. In the absence of consensus, the Commission was left having to make difficult choices on a topic in which it has little historical familiarity, and many of the underlying concepts of the rules defy easy explanation or simple definition.

Third, given the broad scope of the rules and their impact throughout the global supply chain, it simply was not possible or feasible to address every hypothetical situation involving every industry affected. Fourth, we believe the Commission sought to take a principles-based approach, rather than a rules-based one, to many of the interpretive questions so that over time industry and market practices would gain acceptance.

Finally, given the large number of human rights groups and other nongovernmental organizations that are closely monitoring issues concerning labor and supply chain issues generally, as well as the conflict minerals issue more specifically, we believe the Commission sought to use the influence of these groups to help shape emerging industry practices and to act as a counterbalance, were certain companies or industries to stray too far from emerging best practices.

Will the Commission or the Staff issue any further interpretive guidance?

The release accompanying the final conflict minerals disclosure rules is 356 pages in length. Some SEC officials initially stated that while the SEC has received numerous questions and requests for clarification regarding the final rules, the SEC Staff did not have any plans to issue additional guidance (e.g., FAQs) because the release accompanying the final rules provides extensive guidance to reporting companies.

Conversely, at an industry conference in November 2012, two senior officers from the SEC's Division of Corporation Finance suggested that some guidance might indeed be forthcoming. Nevertheless, recent turnover in senior staff at the SEC and the nomination of a new SEC chairman call into question the imminence of any guidance from either the Commission or the Staff. Because the Commission chose to remain silent on many key issues, we question whether the Staff would be in a position to reopen issues when the Commission itself did not reach consensus on them.

Ultimately, the Staff's guidance must have some legal basis, and it could be difficult to find that basis when the Commission has made a policy choice in favor of a principles-, as opposed to rules-, based approach on many of these issues. In the absence of further official clarification or direction on these questions, reporting companies should closely observe their peers and industry groups to keep abreast of any consensus or industry standards that begin to develop.

What about packaging?

The lack of a definition of "product" in the rules raises several related questions, including whether a product's packaging is considered part of the product and, therefore, whether it is covered by the rule. As an example, if a reporting company sells a food product in a tin can, but the food product itself does not contain a conflict mineral, should the tin can be considered in the company's conflict minerals analysis?

The SEC has not issued any guidance on this topic, and the adopting release for the final rule does not discuss packaging. Some commentators draw an analogy to the SEC's exclusion of merely ornamental conflict minerals (e.g., gold embellishment) as not "necessary to the functionality" of certain products; however, others believe that a blanket exclusion of packaging would be too broad and could potentially undercut Congressional intent.

Unless the SEC issues further guidance, or an industry standard develops, reporting companies will be forced to rely on the facts and circumstances of a product and its packaging and make their own determinations. The critical question is whether the packaging is necessary to the functionality or production of the product. For example, if the tin in the can is necessary to prevent spoilage, then an argument could be made that the packaging is an integral part of the product. On the other hand, the availability of alternative packaging that does not include conflict minerals could also factor into the analysis.

Another consideration is whether the packaging itself has any intrinsic value. For example, disposable packaging presumably has little or no value, contrasted with a commemorative gold box that presumably does. A potential offshoot of this uncertainty is that reporting companies are likely to explore ways to replace conflict minerals in packaging (as well as in their core products).

How will the rules be enforced?

The SEC has not announced any particular enforcement program, and it is not yet clear how much of a priority the Staff will place on reviewing filings in 2014, but by analogy we can draw from the experiences surrounding other new disclosure regimes that have been implemented in recent years. In the absence of official guidance from the Commission or the Staff, it would not be uncommon for Commissioners or senior staffers to give speeches and presentations at industry events laying out their preferences and expectations for a new set of rules.

After the first wave of filings, it is possible that examiners in the Division of Corporation Finance could issue individual comment letters to specific registrants, or the Division as a whole may issue more comprehensive disclosure guidance highlighting best practices or areas where large numbers of registrants appear to have missed the mark. Given the two- and four-year transition periods contained in the final rules, the Staff's process of providing feedback may occur more gradually than other recent amendments to public company disclosure rules, such as the rules on Compensation Discussion & Analysis, in which the Staff was very active in providing specific comments and publicizing its more general reactions after the first reporting cycle.

In all but cases involving egregious violations of the rules, we would not expect the Division of Corporation Finance to make a large number of enforcement referrals to the Division of Enforcement in the short to medium term. Over the longer term, it is possible that the Division of Enforcement will seek to bring enforcement cases against registrants that are perceived as materially flaunting the rules. As part of the Division of Enforcement's recent reorganization, a special unit focusing exclusively on the Foreign Corrupt Practices Act has been formed.

This unit has been steadily improving working relationships with foreign regulators and developing increasingly sophisticated techniques for investigating transnational violations of the securities laws. These relationships and techniques would be readily transferable to future investigations of cases involving the conflict minerals rules. Outside of SEC enforcement, a private right of action exists under Section 18 of the Exchange Act for shareholders who perceive irregularities in the filed reports, and we should expect the advocacy and NGO community to also be very outspoken in publicly highlighting perceived violations of the rules.

After JOBS Act, Confidential Filers Rise

Last month, this WSJ article noted that nearly 75% of the companies that filed IPO registration statements between last April and the end of '12 were deemed to be emerging growth companies. And 60% of these EGCs filed their registration statements through the EGC confidential process...

Meanwhile, Gunster's David Scileppi blogs "SEC curtails JOBS Act broker registration exemption in recent FAQs"...

The Court Where Securities Rules Go to Die

Here is an interesting article about the US Court of Appeals for the DC Circuit, noting that no new judge have been appointed since 2006 due to Senate gridlock. There are 3 or 4 vacancies and if President Obama can get his two current nominees confirmed, Srikanth Srinivasan and Caitlin Halligan, the balance of power could be altered. Here is Sandra Day O'Connor's take on one of the nominations...

- Broc Romanek

View today's posts

3/15/2013 posts

Race to the Bottom: Gibbons v. Malone: Differences Between Securities in Same Company Essential when Avoiding the Application of Section 16(b) of the Securities Exchange Act
CLS Blue Sky Blog: Institutional Investors Should Not Facilitate Corporate "Ambushes"
CLS Blue Sky Blog: Rakoff, Naftalis, and Brodsky Discuss the Gupta Insider Trading Case at Columbia Law School Blog: Survey Results: Shareholder Engagement
SEC Actions Blog: This Week In Securities Litigation (Week ending March 15, 2013)
Race to the Bottom: What to Expect This Proxy Season: Findings from Proxy Preview
Delaware Corporate and Commercial Litigation Blog: Chancery and Proxy Puts
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Substantial 2013 Results Already Produced by SRP and SRP-Represented Investors
Race to the Bottom: Union de Empleados v. UBS Financial Services: Appellants Get a Second Chance Blog: Answering Your Conflict Minerals Questions

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